You’ve found your dream home. The asking price is $300,000 — an amount you’ve already been pre-approved for by your bank. But is the home really worth that amount? That’s the question at the heart of the home appraisal. The worth, or value of the property, will determine how much a lender is willing to give you to buy that particular piece of real estate.
This all-important step in getting the financing you need is the home appraisal — an oftentimes-confusing part of the mortgage process in which both buyer and seller must depend on the expert opinion of a stranger. A real estate appraisal is simply that — the expert opinion of a certified, state-licensed professional who determines the value of a piece of property. If your $300,000 dream home is really worth only $200,000, then the home is overpriced.
A home appraisal also protects the bank from getting stuck with property that’s worth less than they’ve invested. And it protects you from paying too much for a house simply because it was love at first sight. The home appraisal is a no-nonsense factor in a decision that is often emotional for the buyer.
A home appraisal is not the same thing as an inspection. If you’re buying a home, you’ll want to hire an experienced home inspector to point out any potential problems that could turn into costly nightmares in the future. Property appraisers will likely make note of any obvious issues, but they won’t test your heat and air, check the chimney or determine if your plumbing is up to code. That’s the job of the inspector.
When you apply for a mortgage, your lender typically requires the property to be appraised by one of their approved appraisers. This practice helps create more consistent appraisals and gives you assurance that the appraiser is properly licensed and certified. Even though the home appraisal is the lender’s requirement, it’s the borrower’s responsibility. You usually pay for it as part of the mortgage costs at the time of closing. The cost is typically around $300 but can be more depending on the price of the property.
There are two primary appraisal methods for residential property. In the sales comparison approach, the appraiser compares the property with three or four similar homes that have sold in the area, often called comparables, or comps. The analysis considers specific components, such as lot size, square footage of finished and unfinished space, style and age of house, as well as other features such as garages and fireplaces.
The cost approach is used more for new property and is based on reproduction costs. The appraiser estimates the cost to replace the structure on the property if it were destroyed. The appraiser then looks at land value and depreciation to determine the property’s worth.
The appraiser gathers information for the appraisal report from a number of sources, but the process often begins with a physical inspection of the property inside and out. Additionally, the appraiser may look at county courthouse records and recent reports from the local real estate multiple listing service.
The appraisal report generally includes:
- an explanation of how the appraiser determined the value of the property
- the size and condition of the house and other permanent fixtures, along with a description of any improvements that have been made and the materials used
- statements regarding serious structural problems, such as wet basements and cracked foundations
- notes about the surrounding area, such as new or established development, rural acreage, and so on
- an evaluation of recent market trends of the area that may affect the value
- a comparative market analysis that supports the appraisal
- maps, photographs and sketches
To learn more about what’s included in the report, take a look at this property appraisal form from Freddie Mac, the second biggest provider of residential mortgages. If you have questions about any aspect of the appraisal, ask the appraiser for clarification.
A common misunderstanding is that the appraisal amount is only for the house itself. In fact, the figure appraises the total value of the home and any other permanent structures, along with the land that the house is built on. This appraisal figure also determines the loan amount you can get to buy the property.
Now you learn that your dream home is valued at $249,000 — a full $51,000 lower than the asking price! Your lender won’t loan more than the appraisal. So what do you do? On the next page we’ll explore how both buyers and sellers can recover from a low appraisal.